Thursday, April 11, 2013
12:33 PM

Reader "JB" thinks I am blaming Germany for what is happening. That's not exactly correct, but let's take a look at what "JB" has to say via email.

Hi Mish,

I read your blog daily. We are generally on the same page. We even agree that in all probability the eurozone will break up. However, You cannot blame the Germany, the German government, or the German people for doing the right thing. Germans can accept austerity. The phrase "tightening the belt" is an axiom in the German language. ....
JB

Hello JB, I think you misunderstand my message. I am not biased against Germany, and I am in favor of "austerity".

By "austerity" I mean shrinkage of public sector jobs and pensions, and liberalization of work rules.

I am against tax hikes, especially those imposed on Spain, Greece, and Portugal by the nannycrats in Brussels. What the nannycrats call "austerity" is nothing more than devastating tax hikes coupled with minimal, if any work rule reforms.

It is mathematically impossible for every country to be an exporter like Germany

It is mathematically impossible for one interest rate to work when there is a multitude of fiscal policies

It is mathematically impossible for the euro to survive without a transfer mechanism of some sort from Germany to peripheral Europe, and Germany will not allow any transfer mechanisms

It is mathematically impossible within the realm of the euro for Spain to be more like Germany, unless Germany is less like Germany

Germany has ruled out everything that could possibly make the eurozone work.

Euro Architects and Politicians to Blame

I do not blame Germany. I blame all the architects of the euro. I also blame all the politicians making matters worse by trying to force their will on the markets. In that sense, I do blame Merkel, but I also blame Hollande, Sarkozy, Trichet, Draghi, and everyone else involved in this mess, past or present.

One Size Fits Germany (Until it Doesn't)

The math of the matter is Germany benefited from the Euro and from the
ECB's "one size fits Germany" interest rate policy more than any other
country.

As a direct result of the unstable eurozone treaty, sovereign interest rate imbalances, Target II imbalance, and trade imbalances are out of control. Germany and the other European creditor countries are owed money that cannot be paid back.

Door Number Two

The eurozone cannot work as is, and
Germany is going to pay the price in one of two ways.

Germany Forgives Loans to European Debtor Nations

The debtor nations exit the eurozone and default

German taxpayers do not want to bail out the rest of Europe. And if I was a German taxpayer I would have the same stance. Without assigning blame to Germany, the math is what it is: unsustainable.

Pick your poison. Is it door number one or door number two? Odds overwhelmingly favor door number two.

George Soros is still a eurozone supporter, but he understands it cannot work without eurobonds. I do not believe the eurozone can work with eurobonds as I expect tensions will be high. Soros' second-best alternative is for Germany to exit the eurozone.

The Eurozone is a failed experiment. Structural flaws were too great
initially, and they have increased over the years. No currency union in
history has ever survived unless there
was also a fiscal union. Current politics says it cannot happen, on
meaningful terms.

Breakup Inevitable, But How?

A breakup is inevitable, just as it has
been from the beginning. The key is to manage a breakup in the least destructive manner.

Breakup Options

Option 1: If Germany (and the northern states) left the eurozone, the
Deutschmark (and respective currencies) would immediately be credible.
The downside to Germany (and the northern states) is debts to German
banks would not be paid back in Deutschmarks
but rather deflated (but not worthless) Euros.

Option 2: The second option is a piecemeal, destructive breakup. Should
Greece and Spain
leave first, those countries might experience a complete loss of faith
in currency resulting in hyperinflation. The Northern states would be
paid back in worthless notes, if they were paid back at all.

Germany Suffers Regardless

Note that Germany and the Northern creditor nations suffer regardless.
Either they keep ponying up bailout money, there is a managed breakup,
or a piecemeal destructive breakup. It would be best for all involved if
Germany left the eurozone and went back to the Deutschmark.

There are no other options, and no other choices. Meanwhile, imbalances grow and German
taxpayers keep funneling tax dollars to the Southern states to keep them afloat.

Merkel Not a Savior

Many Germans view Merkel as a hero for her tough stance on Cyprus.

However, Merkel is neither a savior nor a hero. Her stance is always one of political necessity. Every step of the crisis she has made politically expedient decisions such as caving in to Sarkozy and providing funds for Greece but not for Cyprus.

Sentiment in Germany in favor of holding the eurozone together is strong provided German taxpayers do not have to pony up another dime. The irony is Germany was the main beneficiary of the ECB's "one size fits Germany" interest rate policy that destroyed Spain and peripheral Europe.

Sentiment Does Not Change the Math

Sentiment does not change the eurozone math, but it does impact the way the eurozone breaks apart.

Expect a piecemeal, destructive breakup.

Some will blame Germany. I blame a mathematically unworkable treaty
that was flawed from the beginning. I also blame all the politicians who
supported the idea even though it was fatally flawed.

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